Leiden Law Blog

Out of the shadows…into the sun? Where financial policy meets party autonomy

Outside, the sun is shining bright. In the whole of Europe, weather records are being broken as temperatures reach 35C and up. Likewise, European policy makers are trying to get the banking business out of the shadows and into the sun.

In reaction to the financial crises the western world has been in since 2008, various policy measures have been taken, or are about to be taken. Currently, policy makers on both the global and European level have turned their attention to what is called ‘shadow banking’. In short, this term refers to (financial) activities and entities that are not under the supervision of financial authorities.

As an alternative means of funding, for instance, banks engage in ‘repurchase agreements’ or ‘repo’s’: bank A sells and delivers assets (usually: securities) to bank B and obtains cash in return. After a while, bank A must repurchase (hence the name) the assets from bank B. From an economic perspective, bank A has thus obtained a loan from bank B, while bank B has obtained assets as collateral to secure repayment of that loan.

Interestingly, it was only a decade ago that the European legislature facilitated repo’s. Since 2002, the Collateral Directive (2002/47/EC) dictates that national laws facilitate a (fiduciary) transfer of collateral such as between our banks A and B. Thus, if a national law would prohibit fiduciary transfers of collateral, that law must not apply to repo’s (see Article 6 Collateral Directive and, e.g., art. 7:55 Dutch Civil Code).

Ten years later, the pendulum has swung back. In their efforts to get shadow banking into the sun, European policy makers are considering whether the use of repo’s should be restricted, especially if they are employed by non-banks. In short, the European Commission is considering whether financial policy measures should restrict party autonomy.

The Netherlands legislature has already enacted a law that restricts party autonomy on financial policy grounds. Suppose our banks A and B would have agreed that Bank B could terminate the repo in case bank A falls insolvent and the authorities take certain measures to address bank A’s insolvency. Under the new law, bank B is not allowed to invoke such an agreement (art. 3:267d et seq. Financial Markets Supervision Act).

The European Commission may consider similar measures. But I would argue that party autonomy should only be limited on convincing grounds. Especially if measures limiting party autonomy are to be taken for economic rather than for ethical reasons, the economic argument for such measures must be persuasive. As long as clear economic evidence has not been delivered, financial policy measures should refrain from infringing on party autonomy.

If the European legislature were to restrict the use of repo’s and thus take financial policy measures that limit party autonomy without clear economic evidence or a persuasive ethical argument, it would not bring financial activities out of the shadows and into the sun. It would bring these activities out of the shadows into the rain.